Over the counter traded product and system for offset and contingent trading of commodity contracts

ABSTRACT

A method for facilitating the offset or contingent trading of commodity contracts comprising: providing a futures exchange wherein a futures or option contract based on a first commodity of a commodity type is traded; and automatically registering a trade of the futures or options contract on the futures exchange at a market price for the futures or options contract when an over the counter contract for a second commodity of the commodity type is traded. In certain embodiments, the invention is an over the counter product comprising: a first leg comprising a purchase or sale of a futures contract based on a first commodity; and a second leg comprising a sale or purchase of an over the counter contract based on a second commodity; wherein the first commodity and the second commodity are of the same commodity type and the over the counter traded product trades at a price differential between the two legs; and wherein the purchase or sale of the futures or options contract is automatically registered on a futures exchange when the sale or purchase of the over the counter contract occurs. A system for offset or contingent trading of commodity contracts is also disclosed.

This application claims priority from U.S. Provisional PatentApplication No. 60/678,624, filed May 6, 2005, incorporated herein byreference in its entirety.

BACKGROUND OF THE INVENTION

1. Field of the Invention

The present invention relates to an over the counter traded product anda system of offset or contingent trading of instruments which links anOTC marketplace with a futures exchange via an electronic interface.Particularly, the present invention is directed to a system wherein onecontract is automatically exchanged for another contract on a relatedcommodity.

2. Description of Related Art

Trading of financial derivatives contracts (e.g., futures, options onfutures, forwards, swaps, options on swaps, etc.) for physicalcommodities, natural resources and financial instruments (all generallyreferred to as commodities) is common in both the over-the-counter(“OTC”) and the futures markets. Many of the commodities traded in anOTC market have similar corresponding futures or options contractstraded on futures exchanges. This is for the simple reason that there isa pricing relationship between the futures contract, the underlyingasset on which it is based, and a related OTC derivative. This isparticularly the case in crude oil markets where there is a pricerelationship between the physical wet crude oil and related derivatives.For example, Brent futures, which trade on, for example, the ICE Futures(“ICE Futures”) is linked to a 21 day Brent, Forties and Oseburg (“BFO”)forward contract which then turns into Dated Brent, as traded on, forexample, the IntercontintentalExchange, Inc. (“ICE”). Also because ofthe linkages between different crudes, there are pricing relationshipsbetween different types of crude oil—e.g., there is a price correlationbetween U.S. West Texas Intermediate and the North Sea Brent crude oils,and between North Sea Brent crude oils and other oil markets, such asDubai.

Besides the difference in the type of contract, regulatory supervision,and trading method (open out-cry, voice brokered, auction, electronic,etc.), OTC markets and futures markets differ in that futures marketsare typically anonymous and always clear trades through a centralcounterparty, whereas OTC markets may be traded on a bilateral orcleared basis. This difference is often significant because bilaterallysettled transactions require that the counterparties (e.g., buyers andsellers) accept each other's credit worthiness in relation to contractperformance, whereas in a cleared market, the clearing firm managescollateral for contract performance on behalf of the counterparties.From a purely performance risk perspective (e.g., payment/collection ordelivery/receipt of the asset), cleared contracts are typicallypreferred, especially where counterparties are largely unfamiliar witheach other. In addition, there may be more liquidity in a particularcontract on a particular base commodity (e.g., crude oil, natural gas,electricity, etc.) in either an OTC or futures market, and the investoror principal would typically rather trade in a market having moreliquidity because it gives wider access to price discovery, potentialcounterparties, market information, quantities, and for contractsrequiring physical delivery, delivery dates. In addition, in marketsthat are less liquid, there are potentially fewer counterparties withwhom to trade, and the possibility that counterparties will beunacceptable from a contract performance, and consequently riskperspective, is increased. Alternatively, investors or principals thatmanage open positions up to and throughout the delivery process mayprefer the guaranteed contract performance that clearing provides for aderivative prior to delivery, but upon fulfilling the terms of thecontract, may choose the selectivity that the OTC markets provide interms of potential counterparties and the potential synergies thatnon-anonymous delivery offer.

To take advantage of the OTC market and the futures markets trading insimilar base commodities, a manual process of initiating and offsettingopen positions from one method of contract performance to another iscurrently the norm—usually by completing a form provided by theexchange, and then submitting to the relevant exchange (via phone, fax,online, etc.). For example, suppose a party holds a long position in arelatively illiquid OTC commodity, such as a Dubai crude oil swap, whichis a derivative contract based on a particular type of oil. The partywishes to convert that Dubai swap position into a position in a moreliquid commodity, or a cleared commodity (because it no longer wishes tomaintain contract performance risk for its counterparty to the trade).In this case, the party could convert the Dubai swap to a futurescontract in Brent, which is another derivative of an oil commodity thattypically trades at a price level, or differential, with respect to theDubai crude oil.

According to the prior art, the counterparties would consummate anoffsetting or contingent trade for the Dubai swap in the OTC market,then manually contact a clearing firm to submit the correspondingfutures contract for registration on a futures exchange. The clearingfirm submits a trade as an “exchange for physical” (EFP) or “exchangefor swap” (EFS), depending on the settlement type of contract beingswitched into or out of, and the futures exchange matches the two sidesand advertises the off-exchange trade to the futures market to notifythat an EFP or EFS has taken place. The futures exchange may requestdocumentation from the counterparties as evidence to the correspondingOTC trade to ensure that there has been no abuse under the futuresexchange rules. This method works, but is inefficient. It also leads topotential risk in that there is risk of human error in agreeing to theterms of the trade, confirming with other counterparties, and completinga form for the relevant exchange. There is also a risk that the relevantexchange may refuse to accept the trade (typically because it eitherdoes not reflect market value, or for other regulatory reasons).

What is needed to make the process more efficient and to provideeffective risk management and straight-through processing forcounterparties and reduce operational risk is an automated EFS or EFPprocess that links an electronic OTC market and an electronic futuresexchange and automatically generates an exchange futures position. Afurther need is a system which provides near real-time audit and marketsupervision capabilities for futures exchanges. Another need is a systemthat reduces operational risk for counterparties and provides nearimmediate straight-through processing into back office and riskmanagement systems. Another need is a system that provides enhancedtransparency for the exchanges for EFPs and EFSs.

SUMMARY OF THE INVENTION

The purpose and advantages of the present invention will be set forth inand apparent from the description that follows, as well as will belearned by practice of the invention. Additional advantages of theinvention will be realized and attained by the methods and systemsparticularly pointed out in the written description and claims hereof,as well as from the appended drawings.

According to a preferred embodiment, one example of the invention is amethod for facilitating the offset or contingent trading of commoditycontracts comprising: providing a futures exchange wherein a futures oroptions contract based on a first commodity of a commodity type istraded; and automatically registering a trade of the futures or optionscontract on the futures exchange at the relevant market price for thefutures or options contract when an over the counter contract for asecond commodity of the commodity type is traded.

An alternative embodiment of the invention is an over the counterproduct comprising: a first leg comprising a purchase or sale of afutures or options contract based on a first commodity; and a second legcomprising a sale or purchase of an over the counter contract based on asecond commodity; wherein the first commodity and the second commodityare of the same commodity type and the over the counter traded producttrades at a price differential between the two legs; and wherein thepurchase or sale of the futures or options contract is automaticallyregistered on a futures exchange when the sale or purchase of the overthe counter contract occurs. A system for offset or contingent tradingof commodity contracts is also disclosed.

Yet a further embodiment of the invention is a system for offset orcontingent trading of commodity contracts comprising: an over thecounter contract settled bilaterally; a futures or options contractcleared through a clearinghouse; and a price differential between theover the contract and the futures or options contract; wherein thefutures or options contract is a derivative for a first commodity of acommodity type, and the over the counter contract is a derivative for asecond commodity of the commodity type; wherein upon execution of atrade of the over the counter contract, a trade of the futures oroptions contract representing similar/equivalent quantities of the overthe counter contract is automatically registered on a futures exchange.

It is to be understood that both the foregoing general description andthe following detailed description are exemplary and are intended toprovide further explanation of the invention claimed.

BRIEF DESCRIPTION OF THE DRAWINGS

FIG. 1 is a block diagram of a computer system for electronic trades offinancial products.

FIG. 2 is a flow chart of a method of the offsetting positions from afutures contract to an OTC position using the present invention.

FIG. 3 is a flow chart of a method for offsetting positions from an OTCposition to a futures contract using the present invention.

FIG. 4 is a flow chart of a method for carrying out a contingent offsetposition using the present invention.

DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENT

Reference will now be made in detail to the present preferredembodiments of the invention. The method and corresponding steps of theinvention will be described in conjunction with the detailed descriptionof the system.

The methods and systems presented herein may be used for taking abilateral OTC contract and moving into a cleared position, or taking acleared contract and moving into a bilateral OTC position, orsimultaneously initiating a position in both a bilateral OTC contractand a cleared contract. For purpose of explanation and illustration, andnot limitation, exemplary embodiments are described herein.

The present invention is carried out in an electronic tradingenvironment, such as that provided by ICE. According to the preferredembodiments, the trading environment 100, depicted in FIG. 1, iscomprised of a trading platform 110 which receives price feeds from anover the counter electronic exchange 120 and a futures exchange 130.Trades occurring on either the OTC exchange or the futures exchange arereported to the trading platform 110 so that a user has access to asingle platform for trading both OTC and futures or options contracts.Individual users 20, 22, 24, and 26 are electronically linked to thetrading platform 110 via a network, such as the internet, 118.

The following examples demonstrate aspects of the present invention.

EXAMPLE 1

The following example is explained with reference to FIG. 2. AssumeParty A has an interest in the differential between the Novembercontracts in a Dubai crude oil swap (a bilateral OTC contract) and aBrent crude oil future (a cleared futures contract). Assume he wants tobe long 500 lots in the Brent futures contract and short 500 lots in theDubai OTC swap contract. According to a preferred embodiment, Party Awould access an electronic exchange such as that provided by ICE. Thesteps are:

In step 210, Party A buys a 500 lot November Brent/Dubai EFS on ICE at aprice differential of $6.50. This means that he has sold 500 lots of theNovember Dubai OTC swap contract which is priced by reference to theprevailing price in the November Brent futures market, i.e., theBrent/Dubai EFS is priced with reference to the prevailing Brent futuresmarket.

In step 220, Party A buys 500 lots of November Brent futures at theprevailing market price. If Brent futures were trading at the time ofpurchase at $63.50, he has sold the November Dubai OTC swap at $63.50minus $6.50, or $57.00.

At the time of the transaction, Party A has really bought an OTCposition in Brent crude oil. However, at the time of purchase, in step230, this is immediately automatically transmitted to the futuresexchange, e.g., ICE Futures, as an EFS and is registered onto thefutures exchange as a 500 lot Brent future EFS which is then cleared bya clearing house having a clearing contract with the futures exchange.

In step 240, the details of the trade (excluding price) are publicizedto the futures marketplace and on all trading screens. According to thepreferred embodiment, because the OTC exchange is linked to the futuresexchange, e.g., the ICE platform 110 takes a price feed from ICEFutures, the Brent futures EFS is not likely to be rejected by thefutures exchange as it will not break price and quantity parameters setby the futures exchange.

Following the transaction, Party A has a bilateral Dubai OTC swapcontract with a counterparty, Party B, as well as a cleared 500 lotBrent futures contract. On the other side, Party B will have bought theDubai OTC swap contracts and sold the Brent futures contract.

EXAMPLE 2

The following example is explained with reference to FIG. 4. AssumeParty A has an interest in the November Mars crude oil forward (abilateral OTC contract). Assume he wants to be long 500 lots in the Marscrude oil forward, but is generally viewed as being of unacceptablecredit worthiness by the available counterparties (e.g. buyers andsellers) in the OTC markets. Of the counterparties in the market, mostare willing to execute a bilateral contract with Party A contingent uponit being exchanged for a November WTI futures contract. According to apreferred embodiment, Party A would access an electronic exchange suchas that provided by ICE. The steps are:

In step 410, Party A buys a 500 lot November WTI/Mars Contingent EFP onICE at a price differential of $0.10. This means that he has bought 500lots of the November WTI futures contract which is priced by referenceto the prevailing price in the November WTI futures market, i.e., theWTI/Mars Contingent EFP is priced with reference to the prevailing WTIfutures market.

In step 420, Party A buys 500 lots of November WTI futures at theprevailing market price+$0.10. If WTI futures were trading at the timeof purchase at $63.50, he has bought the November Mars OTC swap at$63.50 minus $0.50, or $63.40.

At the time of the transaction, Party A has really bought an OTCposition in Mars crude oil. However, at the time of purchase, in step430, this is immediately automatically transmitted to the futuresexchange, e.g., ICE Futures, as an EFS and is registered onto thefutures exchange as a 500 lot WTI future EFS which is then cleared by aclearing house having a clearing contract with the futures exchange.

In step 440, the details of the trade (excluding price) are publicizedto the futures marketplace and on all trading screens. According to thepreferred embodiment, because the OTC exchange is linked to the futuresexchange, e.g., the ICE platform 110 takes a price feed from ICEFutures, the WTI futures EFS is not likely to be rejected by the futuresexchange as it will not break price and quantity parameters set by thefutures exchange.

Following the transaction, Party A has a cleared 500 lot WTI futurescontract. Because the bilateral Mars OTC swap contract was contingentupon it being accepted by the futures exchange, there is no resultingOTC position with a counterparty, Party B, On the other side, Party Bwill have sold the WTI futures contract.

EXAMPLE 3

Assume a party maintains a long position in a December Brent crude oilfuture (a cleared futures contract) and wants to manage the commoditybilaterally during a delivery phase to make a profit (i.e., wants to belong in a similar bilateral OTC forward contract). Referring to FIG. 3,the steps are:

1. In step 310, party A sells a 300 lot Brent/BFO (or Brent, Forties andOseburg Blend—the typical physically delivered crude oil grades in theNorth Sea)) EFP on the ICE platform at a price differential of $1.00.This means that he has sold a Brent crude oil future and correspondinglypurchased a BFO Blend crude oil OTC forward contract at a pricedifferential between the two commodities. The sale of the Brent futureis automatically registered on the future exchange when the OTC forwardpurchase occurs.

2. In step 320, party A sells a December Brent crude oil futurescontract at the prevailing market price. If Brent futures were tradingat the time of purchase at $63.50, he has bought the BFO OTC forward at$63.50 minus $1.00, or $62.50.

At the time of the transaction, Party A has really sold an OTC positionin Brent crude oil. However, at the time of sale, in step 330, this isimmediately automatically transmitted to the futures exchange, e.g., ICEFutures, as an EFP and is registered onto the futures exchange as a 300lot Brent future EFP which is then cleared by a clearing house having aclearing contract with the futures exchange.

Following the transaction, Party A has a bilateral BFO OTC forwardcontract with a counterparty, Party B, as well as an offset of 300 lotof the Brent futures contract for his existing futures position. On theother side, Party B will have sold the BFO OTC forward contract andbought the Brent futures contract.

It will be seen in that in the above Example 2, a futures contract isoffset and reestablished as an OTC position.

Because the EFP/EFS is only traded at a differential, it is linked to afutures anchor price, which is the then-existing market clearing pricefor the future and the EFP/EFS does not negatively affect pricediscovery on the futures market. Moreover, at the point of execution,although the two markets (OTC and futures) are linked, the product is anOTC product and is only registered automatically on the futures marketto show that a trade has occurred and that a futures position has beencreated. Thus, disclosure is made in the futures market withoutaffecting the price of that market. Additionally, because thecounterparties preferably consummate the OTC leg of the tradeelectronically, their identities are known to the exchanges and readilyreportable for documentation purposes.

Aside from the above presented examples, other bilateral and clearedcontracts can be traded as an EFS or EFP. Where the underlying commoditytype is energy, the related first and second commodities may be, forexample: natural resources or related natural resource instruments, suchas, crude oil, refined crude oil products, natural gas, electricity,emissions, coal, liquid natural gas, natural gas liquids, weather, biofuels, nuclear, fuel, petrochemicals, hydroelectric energy generation,solar energy generation, wind energy generation, and others. For oil,the related first and second commodity may be, for example: oil futures,oil forwards, oil options (European, American, Asian style), oilswaptions, rolling date forwards, contracts for difference, front lineswaps, fixed for floating swaps, float for float swaps, index swaps, andothers. Other commodity types may include precious metals, base metals,currency, agricultural commodities, fixed income financial futures, andothers.

It will be apparent to those skilled in the art that variousmodifications and variations can be made in the method and system of thepresent invention without departing from the spirit or scope of theinvention. Thus, it is intended that the present invention includemodifications and variations that are within the scope of the appendedclaims and their equivalents.

1. A method of offset or contingent trading comprising: providing afirst financial exchange configured for offering for sale or purchase afirst financial derivatives contract; providing a second financialexchange and offering for purchase or sale a second financialderivatives contract; consummating, via an electronic trading platform,one of an offsetting and contingent trading transaction for the secondfinancial derivatives contract at a price differential that is based onprevailing market prices as indicated by the first exchange and saidelectronic trading platform automatically registering a trade of thefirst financial derivatives contract on the first financial exchangeimmediately upon consummating the trading transaction for the secondfinancial derivatives contract, wherein the first financial exchange isone of a futures exchange and an over-the-counter (OTC) exchange, andwherein the second financial exchange is the other of said futuresexchange and said OTC exchange.
 2. The method of claim 1, wherein thefirst financial derivatives contract corresponds to the consummatedtrading transaction.
 3. The method of claim 2, wherein the one of anoffsetting and contingent trading transaction is one of an exchange forphysical (EFP) and exchange for swap (EFS) transaction.
 4. The method ofclaim 3, further comprising publicizing details of the trade for thefirst derivatives contract to marketplace participants of the firstexchange.
 5. The method of claim 4, wherein the first financialderivatives contract is a futures or options contract, wherein the firstfinancial exchange is a futures exchange, wherein the second financialderivatives contract is an OTC bilateral contract, and wherein thesecond financial exchange is an OTC exchange.
 6. The method of claim 5,wherein the OTC bilateral contract is one of a swap, forward and optionscontract.
 7. The method of claim 1, wherein the first financialderivatives contract is based on a first commodity of a commodity type,and wherein the second financial derivatives contract is based on asecond commodity of said commodity type.
 8. The method of claim 7,wherein the commodity type is one of energy, oil, precious metals, basemetals, currency, agricultural commodities, and fixed income financialfutures.
 9. The method of claim 8, wherein the commodity type is energyand wherein the first and second commodities are selected from the groupconsisting of natural gas, crude oil, refined crude oil products,electricity, emissions, coal, liquid natural gas, natural gas liquids,weather, bio fuels, nuclear fuel, petrochemicals, hydroelectric energygeneration, solar energy generation, and wind energy generation.
 10. Themethod of claim 7, wherein the commodity type is oil and wherein thefirst and second commodities are selected from the group consisting ofoil futures, oil forwards, oil options, oil swaptions, rolling dateforwards, contracts-for-difference, front line swaps, fixed-for-floatingswaps, float-for-float swaps, and index swaps.
 11. A system for offsetand contingent trading in an electronic trading environment, the systemcomprising: an electronic trading platform; two or more exchanges incommunication with the electronic trading platform, the exchangesproviding price feeds and reporting trades to the electronic tradingplatform; and one or more user terminals in communication with theelectronic trading platform, the user terminals providing access to theprice feeds and trades reported to the electronic trading platform,wherein the electronic trading platform is configured to: consummate oneof an offsetting and contingent trading transaction by offering for saleor purchase a first financial derivatives contract on a first of theexchanges; offer for purchase or sale a second financial derivativescontract on a second of the exchanges at a price differential that isbased on prevailing market prices as indicated by the first exchange;and automatically register a trade of the first financial derivativescontract on the first exchange upon a trade of the second financialderivatives contract and wherein said first of the exchanges is one of afutures exchange and an OTC exchange, and wherein said second of theexchanges is the other of said futures exchange and said OTC exchange.12. The system of claim 11, wherein the first exchange is a futuresexchange, wherein the second exchange is an OTC exchange, and whereinthe electronic trading platform is configured to move a bilateral OTCcontract into a cleared position upon consummating one of an offsettingand contingent trading transaction.
 13. The system of claim 12, whereinthe electronic trading platform is further configured to move a clearedcontract into a bilateral OTC position upon consummating one of anoffsetting and contingent trading transaction.
 14. The system of claim13, wherein the electronic trading platform is further configured tosimultaneously initiate a position in both a bilateral OTC contract anda cleared contract upon consummating one of an offsetting and contingenttrading transaction.
 15. The system of claim 12, wherein the firstfinancial derivatives contract is one of a futures and options contract,and wherein the first exchange is a futures exchange.
 16. The system ofclaim 12, wherein the second financial derivatives contract is anover-the-counter (OTC) bilateral contract.
 17. The system of claim 16,wherein the OTC bilateral contract is one of a swap, forward and optionscontract.
 18. The system of claim 17, wherein the first and secondfinancial derivatives contracts are based on one of commodities, naturalresources, and financial instruments.
 19. The system of claim 18,wherein the first financial derivative contract is for a first commodityof a commodity type and wherein the second financial derivative contractis for a second commodity of said commodity type.
 20. The system ofclaim 19, wherein the commodity type is one of oil, natural gas, andenergy.